Related topics: funds, bond funds, mutual funds, investing strategy, Kiplinger
After all we've suffered over the past decade, it's easy to see why we're flocking to the investment equivalent of comfort food. Heaps of supposedly supersafe Treasury bonds help us sleep at night after a diet of stocks left us stressed and hungry. And no wonder: The U.S. stock market has lost about 2% annualized over the past 10 years, while Barclays Capital Aggregate Bond Index, which measures high-quality bonds, gained a savory 6.5% a year.
Our appetites are reflected in the flow of money in and out of mutual funds. In June, the most recent month for which data are available, domestic-stock funds lost $6.1 billion more than they took in. In the same month, taxable-bond funds gained nearly $18.6 billion (mostly in short-term funds), and municipal-bond funds netted $1.6 billion.
Fran Kinniry, a senior member of Vanguard's Investment Strategy Group, says that investor behavior today is "no different than it was in the late 1990s." During that rollicking bull market, he says, everyone wanted to be in big-company and technology stocks. The party ended in early 2000 with the bursting of the tech bubble.
Now investors have "disproportionately bought into fixed income," says Kinniry, and they may again be moving into the wrong place at the wrong time. This time the culprit is likely to be an increase in interest rates.
Rates have been cranked so low by governments trying to stimulate their battered economies and by investors pouring money into supposedly safe bonds that they have nowhere to go but up. When that happens, prices of many bonds are sure to fall. And if the pessimists are right about a coming double-dip recession and lukewarm economic growth, bond investors may be vulnerable to rising defaults among issuers of corporate, foreign and municipal bonds.
Given the performance of stocks over the past decade, you may be tempted to downplay or even avoid them. But while stocks are more volatile than bonds, historically they have returned an average of 4 percentage points per year more. As a result, "rushing wholeheartedly into bonds can play havoc with a portfolio," says Kinniry.
A sleep-tight strategy
The best way to protect yourself from economic uncertainty, market anxiety and your own rash judgment -- and still produce a good yield -- is to assemble a portfolio of solid mutual funds that pay both good dividends and high interest. A well-diversified income portfolio should include some standards, such as funds that invest in utilities and real estate (we'll name our favorites in those and other categories later and offer suggestions for using them in your portfolio).
It should also include overseas investments. Owning foreign stocks and bonds offers two advantages. First, some of the highest-yielding securities come from overseas. Second, owning assets denominated in foreign currencies reduces the volatility of a portfolio.
Kathleen Gaffney, a co-manager of Loomis Sayles Bond, says her fund owns government debt from Mexico and Brazil with investment-grade ratings (meaning there's little likelihood that those countries will default on their obligations). Not only are such countries growing faster than most more-developed nations, their capital markets are becoming mature and their governments more stable.
U.S. investors can take advantage of differences in economic and business cultures overseas. Jesper Madsen, the lead manager of the Matthews Asia Dividend Fund, points out that many companies going public in Asia are family-owned and that the best way for the owners to take money out of a company is to pay dividends, allowing family members and investors to share the wealth. Likewise, governments that spin off their "crown jewels" to the public want to keep income flowing back to their coffers through dividends.
Below, we describe 10 great funds for putting more cash in your pocket. For the latest data on these and more than 3,000 other funds, try Kiplinger's Fund Finder.
